Week 7 - Cash Flow Statement

Question 1

What does a positive cash flow permit a company to do?

Answer 1

Take advantage of market opportunities
Pay dividends to owners
Expand its operations
Replace worn assets

Question 2

What does the statement of cash flows show?

Answer 2

Changes in cash and cash equivalents during a period
Cash comprises cash on hand and on demand deposits

Question 3

What are cash equivalents?

Answer 3

Short term
Highly liquid investments
Readily convertible to known amounts of cash
Which are subject to insignificant risk of change in value

Question 4

What are the three sections of cash flow statement?

Answer 4

CF from operating activities
CF from investing activities
CF from financing activities

Question 5

What does operating cash flow show?

Answer 5

Operating activities include cash received and paid related to selling goods and rendering services
and are directly related to the company’s primary day-to-day business activities.

Question 6

What are some examples of positives and negatives on operating cash flows?

Answer 6

+ : Sale of goods, Rendering of services, Royalties, Fees, Commission

• : Payment to suppliers, Other expenses, Employees’ wage

Question 7

What does a healthy operating cash flow show and allow?

Answer 7

• A financially healthy company generates sustained cash inflows
  from selling goods and providing services.
• The amount of cash flow from operations indicates the extent to
  which operating activities generate more cash than they use.
• A firm can use cash flow from operations to acquire buildings
  and equipment, pay dividends, retire long-term debt, and pay
  for other investing and financing activities.

Question 8

What does investing cash flows show?

Answer 8

• The acquisition of noncurrent assets, particularly property, plant,
  and equipment, usually represents a major ongoing use of
  cash.
• Firms not experiencing rapid growth can often finance the
  acquisition of noncurrent assets with cash flow from operations.
• Rapidly growing firms must often borrow funds or issue
  common shares to finance these acquisitions.

Question 9

What are examples of investing cash flows?

Answer 9

+ : Sale of PPE, Sale of shares of other companies, Collection of loans made to other entities

• : Cash payments to acquire PPE, Buying shares of other companies, Lending money

Question 10

What does a financing cash flow show?

Answer 10

A firm obtains cash from borrowing and from issuing shares.
It uses cash to pay shareholders dividends, repay borrowing, and acquire own shares.
These amounts appear as cash flow from financing activities in the statement of cash flows.

Question 11

What are examples of financing cash flows?

Answer 11

+ : Issuing shares, Issuing notes and bonds, Obtaining bank loans

• : Cash payments to acquire own shares, Principal repayments on loans, Payment of dividends

Question 12

What are the 4 phases of the corporate life cycle?

Answer 12

Introductory, Growth, Maturity, Decline

Question 13

Draw the typical corporate life cycle of a cash flow (labelled)?

Answer 13

Finance originally high and declines
Operating stats negative and increases before decline phase when it decreases
Investing begins negative and slower than operating it becomes positive until decline phase when it decreases

Question 14

What are the two methods of preparing the statement of cash flows?

Answer 14

Direct method:
-Examine all cash transactions that occur during the period
-Group them accordingly to the type of activity

Indirect method
-Start with net income, adjust for non cash transactions and working capital changes

Question 15

In which order is the statement of cash flow structure?

Answer 15

Operating
Investing
Financing

Question 16

Using the indirect method how would you calculate net cash flows from operating activities?

Answer 16

Profit before tax + (+Depreciation/Amortization expense
+Loss/-Profit on disposal of non-current assets
+/– provision increases /decreases) + (Interest expense) + (+decrease/−increase in inventories) + (+decrease/−increase in receivables/prepayments) + (+increase/−decrease in payables) - (Interest paid) - (Taxation paid) - (Dividend paid) = Net cash flows from operating activities

Question 17

Why is the indirect method preffered?

Answer 17

Easier and less expensive

Companies that use the direct method are required to present a supplemental disclosure showing the reconciliation of net income to cash from operations.

Question 18

Why do we add back depreciation to the profit before taxation?

Answer 18

Depreciation is a non cash expense that reduces the profit but not the actual cash flow.

Question 19

When creating the operating cash flow what do you do with (Depreciation/amortization/impairment losses/ provision for doubtful
debt increases) from the income statement? Why do you do what you do?

Answer 19

They are added back.
* these expenses eg, depreciation, were deducted in calculating
net profit
* they have no effect on cash flows
* So they are added back

Question 20

When creating the operating cash flow what do you do with (gain on disposal of non-current assets) from the income statement? Why do you do what you do?

Answer 20

They are subtracted
* gain was added in calculating net profit
* this is an investing (not operating) cash flow
* we subtract the gain, calculate cash received from disposal and
include this figure in investing cash flows (note that gain/loss on
disposal does not equal cash received from selling non-current
assets)

Question 21

When creating the operating cash flow what do you do with (loss on disposal of NCA) from the income statement? Why do you do what you do?

Answer 21

They are added back
* loss was deducted in calculating net profit
* we add back the loss, calculate cash received from disposal and
include this figure in investing cash flows

Question 22

When creating the operating cash flow what do you do with (Interest income) from the income statement? Why do you do what you do?

Answer 22

It is subtracted
* interest income was added in calculating net profit
* we subtract the interest income (IS figure)
* we calculate cash received and include this figure in investing or
operating cash flows

Question 23

When creating the operating cash flow what do you do with (interest expense) from the income statement? Why do you do what you do?

Answer 23

It is added back
* interest expense was deducted in calculating net profit
* we add back the interest expense (IS figure)
* we calculate interest paid and include this figure in financing or
operating cash flows

Question 24

How is Interest paid (cash outflow) calculated? Where is this figure included?

Answer 24

Opening interest liability (interest payable, SOFP)
+ Income Statement charge (i.e. interest expense)
- Closing interest liability (interest payable, SOFP)

Interest and dividends paid may be classified as operating or financing cash flows (under IFRS).

Question 25

How is Tax paid (cash outflow) calculated?

Answer 25

Opening tax liability (tax payable, SOFP)
+ Income Statement charge (i.e. tax expense)
- Closing tax liability (interest payable, SOFP)

Question 26

How is cash collected from customers calculated? What is the adjustment required for the indirect method?

Answer 26

TR beg + Credit sales - TR end

Since Net profit figure already includes credit SALES, the adjustment that is required for the indirect method is:
NET PROFIT -/+increase/decrease in receivables

Question 27

When calculating cash flow from operations, why is the change in inventory added or subtracted from profit before taxation?

Answer 27

Because an increase in inventory represents a cash outflow that hasn’t affected profit but reduces cash flow.

Question 28

When creating the CFO what adjustments are made to a change in trade receivables? Why?

Answer 28

Increase – Subtracted
Decrease - Added

• To adjust for revenue earned but not yet received in cash, as it affects actual cash flow.
• Increase in receivables means less cash was collected, hence subtracted from the profit.
• Decrease in receivables means more cash was collected, hence added to the profit.

Question 29

When creating the CFO what adjustments are made to a change in inventory? Why?

Answer 29

Increase – Subtracted
Decrease - Added

• To adjust for changes in inventory that may not have affected profit
  directly.
• An increase in inventory represents cash spent on purchasing stock that has not been sold. Hence it will not show up in the profit. We have to subtract from profit.
• A decrease in inventory means goods were sold, thus generating
  cash. We have to add this to the profit.

Question 30

When creating the CFO what adjustments are made to a change in payables? Why?

Answer 30

Increase – Added
Decrease - Added

• An increase in accounts payable indicates that purchases were made on credit, meaning less cash outflow. This increase is added
  to profit.
• A decrease in accounts payable suggests cash was used to pay
  suppliers. This amount is subtracted from profit.